Chapter 8: Measuring Life-Cycle Costs
– 307 –
8-33 As shown below, Greyson will now never reach a break-even time.
Beginning with Y4, Q4, Greyson will incur quarterly losses of $20,000 and
will never show a positive cumulative profit.
(000)
Y1,
Q1
Y1,
Q2
Y1,
Q3
Y1,
Q4
Y2,
Q1
Y2,
Q2
Y2,
Q3
Y2,
Q4
Market
Research
$(100)
$(50)
Product
Development
(80)
(150)
(150)
(150)
(150)
(150)
(150)
Selling Price
Cost per unit
Margin/unit
Sales
quantity
Contribution
MSDA
expenses
Product
profit
Quarterly
Profit/Loss
$(100)
$(130)
$(150)
$(150)
$(150)
$(150)
$(150)
$(150)
Cumulative
Profit/Loss
$(100)
$(230)
$(380)
$(530)
$(680)
$(830)
$(980)
$(1,130)
(000)a
Y3,
Q1
Y3,
Q2
Y3,
Q3
Y3,
Q4
Y4,
Q1
Y4,
Q2
Y4,
Q3
Y4,
Q4
Market
Research
Product
Development
$(60)
Selling Price
$18
$17
$17
$16
$15
$15
$15
$15
Cost per unit
10
10
10
10
10
10
10
10
Margin/unit
$8
$7
$7
$6
$5
$5
$5
$5
Sales quantity
20
30
40
45
45
35
30
20
Contribution
$160
$210
$280
$270
$225
$175
$150
$100
MSDA
expenses
120
120
120
120
120
120
120
120
Product profit
$40
$90
$160
$150
$105
$55
$30
$(20)
Quarterly
Profit/Loss
$(20)
$90
$160
$150
$105
$55
$30
$(20)
Cumulative
Profit/Loss
$(1,150)
$(1,060)
$(900)
$(750)
$(645)
$(590)
$(560)
$(580)
aAll amounts except selling price, cost per unit, and margin per unit are in 1,000s.
Atkinson, Solution Manual t/a Management Accounting, 6E
– 308 –
8-34 To use activity-based costing to help control and reduce environmental costs,
the activities that cause environmental costs must be identified. Next, the costs
associated with the activities must be determined. These costs must then be
assigned to the most appropriate products, distribution channels and customers.
As in all types of management accounting and control systems, it is only when
managers and employees become aware of how the activities in which they
engage generate environmental costs that they can control and reduce them.
Environmental costs include explicit costs, such as the direct costs of
modifying technology and processes, costs of cleanup and disposal, costs
for permits to operate a facility, fines levied by government agencies and
litigation fees. Implicit environmental costs are often more closely tied to
the infrastructure required to monitor environmental issues. These costs
include administration and legal counsel, employee education and
awareness, and the loss of goodwill if environmental disasters occur. Using
traditional cost systems, environmental-related costs are often hard to
pinpoint because they are usually hidden in support cost pools.
PROBLEMS
8-35 (a) To prepare an exhibit similar to Exhibit 8-9, first compute the relative
cost percents illustrated in Exhibit 8-6 and the relative rankings
illustrated in Exhibit 8-7.
Function Group
Target
Cost
Percent
of Cost
Chassis
$1,400
20.0
Transmission
280
4.0
Air conditioner
100
1.4
Electrical system
700
10.0
Other function groups
4,520
64.6
Total
$7,000
100.0
Customer Requirements
Importance
Relative Ranking in
Percent
Safety
140
28%
Comfort and convenience
120
24%
Economy
40
8%
Styling
60
12%
Performance
140
28%
Total
500
100%
Chapter 8: Measuring Life-Cycle Costs
– 309 –
Function Group
Customer
Requirements
Chassis
Trans-
mission
Air
Condi-
tioner
Electrical
System
Other
Function
Groups
Relative
Feature
Ranking
Safety
0.3
28% =
8.4%
0.1
28% =
2.8%
0.1
28% =
2.8%
0.5
28% =
14%
28%
Comfort and
convenience
0.3
24% =
7.2%
0.1
24% =
2.4%
0.1
24% =
2.4%
0.5
24% =
12%
24%
Economy
0.2
8% =
1.6%
0.2
8% =
1.6%
0.1
8% =
0.8%
0.1
8% =
0.8%
0.4
8% =
3.2%
8%
Styling
0.1
12% =
1.2%
0.9
12% =
10.8%
12%
Performance
0.3
28% =
8.4%
0.2
28% =
5.6%
0.1
28% =
2.8%
0.4
28% =
11.2%
28%
Converted
component
ranking
26.8%
10.0%
3.2%
8.8%
51.2%
100%
(b) The value index is a benefit/cost ratio, obtained by dividing the
relative importance in column (3) by the associated relative cost
column (2).
(2)
(3)
(3) (2)
Function
Relative
Value
Action
Group
Cost
Importance
Index
Implied
Chassis
20.0%
26.8%
1.34
Enhance
Transmission
4.0%
10.0%
2.50
Enhance
Air
conditioner
1.4%
3.2%
2.29
Enhance
Electrical
system
10.0%
8.8%
0.88
Reduce cost
Other function
groups
64.6%
51.2%
0.79
Reduce cost
Atkinson, Solution Manual t/a Management Accounting, 6E
– 310 –
(c) The electrical system and other function groups are candidates for
cost reduction because their value indexes are less than 1.
8-36 The traditional focus of cost management has been only on manufacturing
processes. Under this approach, pre-manufacturing costs, such as research
and development, and post-manufacturing costs, such as service, are
considered period costs, and companies expense them in the period
incurred. Thus, these costs are in no way linked to individual products.
Traditional accounting procedures and the way that many organizations
have been separated by department or function (e.g., design engineering,
manufacturing, marketing, logistics, installation and postal service), often
lead managers to focus myopically on their own department’s costs. In
particular, for the manufacturing function, defining product costs as those
solely related to the manufacturing process ignores many costs associated
with the entire life cycle cost of a product.
Understanding the total life cycle costs (TLCC) of a product or service, or
the product costs incurred before, during, and after the manufacturing cycle
is critical, as decision makers can more completely analyze and understand
what creates product costs. For example, if a company can reduce a
product’s design and development costs at the pre-manufacturing stage, it
also is possible to reduce all other subsequent product-related (downstream)
costs such as manufacturing and service-related costs. A TLCC system
provides information for managers to understand and manage costs through
a product’s design, development, manufacturing, marketing, distribution,
maintenance, service, and disposal stages. The total life approach is also
known as managing costs “from the cradle to the grave.”
8-37 Gregoire Grant is shortsighted. The manufacturing cycle of the total-life-
cycle costing approach is only one of three major stages of the product life
cycle concept. The other life cycle concepts are research, development and
engineering, and post-sale service and disposal. While each concept is
useful within its respective functional area, from a total-life-cycle costing
(TLCC) perspective, it is important to integrate the concepts and to
understand them in their entirety. Such integration allows managers to see
the big picture and to manage whole-life product costs in a comprehensive
fashion. For example, poor decisions in the research development and
engineering stage may lead to much higher costs in the manufacturing and
post-sale service stages. Thus, it is in Gregoire’s best interest to understand
what is occurring in the research development and engineering stage.
Chapter 8: Measuring Life-Cycle Costs
– 311 –
In order for managers at Gregoire’s company to fully adopt the TLCC view,
it will probably be necessary to break down what are called “functional
silos.” Functional silos are traditional parts of organizations that are often
thought (by those in them) to be self-contained. Breaking these down often
means reorganizing the company into cross-functional teams who share a
vision of integration across their previous functions. Another critical aspect
to understanding the importance of the TLCC perspective is management
education. The company should consider educational programs in which
their managers can learn about the benefits of and gain commitment to the
TLCC perspective.
8-38 The target cost for a Calcutron calculator is computed as follows:
Target sales (500,000 calculators $75)
$37,500,000
Less: Target profit (15% $75/calculator 500,000
calculators)
5,625,000
Target cost for 500,000 calculators
$31,875,000
Unit target cost ($31,875,000/500,000 calculators)
$ 63.75
8-39 To compute the return on sales (ROS) for Bill Mann, it is necessary to
determine Bill’s profit margin:
Sales (300,000 units $500) $150,000,000
Less: Expenses 90,000,000
= Profit Margin (ROS Sales) $60,000,000
ROS $150,000,000 = $60,000,000, so ROS = 40%.
Thus, Bill Mann has not met the company-wide return-on-sales target of
45%. Assuming Bill’s initial target costs and target sales prices were
consistent with the company-wide return-on-sales target, Bill should explain
the causes for below-target performance. Potential problem areas include
manufacturing costs and misestimation of customer demand for the
products’ functionality at the target prices. Evaluating whether Bill has done
a good or poor job will involve determining the extent to which Bill could
control cost, and evaluating Bill’s judgment in setting prices.
8-40 Some studies of target costing in Japan indicate that there are potential
problems in implementing the system, especially if focusing on meeting the
target cost diverts attention away from other elements of overall company
goals. These potential problems include the following:
Atkinson, Solution Manual t/a Management Accounting, 6E
– 312 –
(1) Senior executives and workers may reject target costing. Education
about the benefits of target costing should be provided in order to
gain top management commitment to target costing, and top
management commitment should be communicated to employees
involved in the target costing process.
(2) Conflicts can arise between various parties involved in the target
costing process. First, companies can put excessive pressure on
subcontractors/suppliers to conform to the schedule and to reduce
their costs. This can lead to alienation and/or failure of the
subcontractor. Second, design engineers become very upset when
other parts of the organization are not as cost conscious as they are.
Since they work very hard to squeeze pennies out of the cost of a
product, they think that other parts of the organization
(administration, marketing, distribution) should also be as cost
conscious. Often this is not the case.
To overcome this problem, pressure can be reduced on
subcontractors/suppliers by giving them reasonable grace periods
over which cost reduction must occur. Simply demanding cost
reduction immediately will exacerbate the conflict. The issue of
design engineers also can be addressed by making other parts of the
organization as cost conscious. Adopting a total-life-cycle costing
approach and using cross-functional teams will help the organization
to this end.
(3) Employees in many Japanese companies working under target costing
goals experience burnout due to the pressure to meet the target cost.
Burnout is particularly evident for design engineers.
This issue can be addressed by making target-costing goals tight, but
attainable. Often organizations make the mistake of setting
impossible goals. Design engineers also often fear that if they make
the target, in the next period, the target will be “ratcheted up” and
made even more difficult to achieve. Thus, they may consciously try
to make sure that they do not achieve the target unless their jobs rest
on it. The organization has to be careful not to burn out employees,
and design engineers in particular, as they are extremely valuable to
the organization. Burnout is probably the biggest issue related to the
success or failure of target costing in Japan.
Chapter 8: Measuring Life-Cycle Costs
– 313 –
(4) While the target cost may be met, there may be increased
development time because of repeated value engineering cycles to
reduce costs, which ultimately can lead to the product being late
getting to market. For some types of products, being six months late
to market may be far more costly than having small cost overruns.
This is a very serious problem for the organization. Clearly, there is a
tradeoff between continuing to reduce target costs and being very late
to market. However, on average, many months of lost sales will have
a much more detrimental effect on the organization than whether
target costs are met. Thus, the organization has to take a reasonable
approach to target costing and not lose sight of the ultimate goal of
selling the product and increasing market share. Time limits can be
put in place for the length of time allowed to develop or introduce
new products.
8-41 There are some similarities between traditional cost reduction and target
costing, but the differences are more striking. Both the traditional costing
method and target costing begin with market research into customer
requirements followed by product specification. Under traditional cost
reduction, companies engage in product design and engineering, and obtain
prices from suppliers. Product cost at this stage is not a significant factor for
product design. After the engineers and designers have determined product
design, they estimate product cost and if the estimated cost is too high, then
product design may have to change. The desired profit margin is found by
subtracting the estimated cost from the expected selling price. Profit margin is
the result of the difference between the expected selling price and the estimated
production cost. Under another traditional method, cost-plus, the expected
profit margin is added to the expected product cost and selling price is the
result of the sum of these two variables.
Under target costing, after market research to determine customer
requirements and product specification, the process is quite different. The
next step, determining a target selling price and target product volume,
depends on the company’s perceived value of the product to the customer.
The target profit margin results from a long-run profit analysis, often based
on return on sales (net income/sales). The target cost is the difference
between the target selling price and the target profit margin.
Once the target cost is set, the company must determine target costs for each
component. The value engineering process includes examination of each
component of a product to determine whether it is possible to reduce costs
while maintaining functionality and performance. In some cases, product
Atkinson, Solution Manual t/a Management Accounting, 6E
– 314 –
design might change, materials used in production might need replacing, or
manufacturing processes might require being redesigned. Suppliers also
play a critical role in making target costing work. If manufacturers with
market power decide that there is a need to reduce the cost of specific
components, they will pressure suppliers to find ways to reduce costs.
8-42 Bringing in outside consultants to implement a target costing system can be
effective, but costly. Consultants often have a great deal of knowledge that
they can bring to an organization and in this sense the organization does not
have to “start from scratch.” A downside of using consultants is that, in
some instances, consultants want to use an existing template for
implementing a new method, such as target costing. The template is often
designed generically and is meant to be superimposed on any organization.
Some organizations object to this and want a more tailored approach,
especially if they are in an industry in which the consultants have not
worked at all. Consultants may agree to tailor the approach, but the cost of
implementation of a target costing system will increase significantly.
A second downside is that many organizational members may not be
involved with implementing the changes. Thus, they may simply rely on
what the consultants do. If organizational members do not understand what
the consultants have done or how the system works, then the system will
likely fail after the consultants leave.
A second approach is for organizational members to develop a target
costing system internally with little or no assistance from outside
consultants. This approach can be satisfying, but it can be costly and time-
consuming, especially if the organization has little experience in
implementing these types of systems. The positive side of this is that
organizational members may get more of a “buy–in” to the new method
because they have to understand it well to convince others of the need to
implement it. Once organizational members know that they can develop
these systems themselves, they may be more confident in the future
regarding the implementation of other organizational innovations.
The third approach, known as benchmarking, requires that organizational
members first understand their current cost reduction methods and then look
externally to the best target costing systems of other organizations for
guidance on change. Benchmarking is often highly cost-effective since
organizations can save time and money avoiding the mistakes that other
companies have made or by avoiding reinventing a process or method that
other companies have already developed and tested. Benchmarking allows
Chapter 8: Measuring Life-Cycle Costs
– 315 –
organizations to gain insights on target costing from others, but at the same
time to assume responsibility for the changes. In this way, organizational
members feel like they have ownership of the changes and this can lead to
developing more confidence about future changes and improvements to
their management accounting system.
8-43 The answer to this question is very similar to the solution for 8-41 but it is
more detailed. The process involved in traditional cost reduction as
practiced in the United States is significantly different from target costing.
The traditional costing method begins with market research into customer
requirements followed by product specification. Then, companies engage in
product design and engineering, and they obtain prices from suppliers.
Traditionally, at this stage, product cost is not a significant factor for
product design. After the engineers and designers have determined product
design, they estimate product cost
Ct
, where the t subscript indicates
numbers derived under a traditional, sequential design and development
process. If the estimated cost is considered to be too high, then it might be
necessary to modify product design. In order to find the desired profit
margin
P
t
, it is necessary to subtract the estimated cost from the expected
selling price
St
. The profit margin is the result of the difference between
the expected selling price and the estimated production cost. This
relationship in the traditional system is expressed as:
P S C
t t t
.
Another widely used traditional approach is the cost-plus method. Under
cost-plus, an expected profit margin Pcp is added to the expected product
cost Ccp where the subscript cp indicates numbers derived under cost-plus
thinking. Selling price Scp, then, is simply the result of the sum of these two
variables. In equation form, this relationship for the cost-plus approach is:
S C P
cp cp cp
. As in the first traditional method described above, product
designers do not attempt to achieve a particular cost target.
Under target costing, both the sequence of steps and way of thinking about
determining product costs differ significantly from traditional costing. The
first two steps, market research to determine customer requirements and
product specification, are similar to traditional costing. After these initial
steps, the process is quite different. The next step, determining a target
selling price
Stc
and target product volume, depends on the company’s
perceived value of the product to the customer. The target profit margin
P
tc
results from a long-run profit analysis, often based on return on sales
(net income/sales). Return on sales is the most widely used measure, as it
Atkinson, Solution Manual t/a Management Accounting, 6E
– 316 –
can be linked most closely to profitability for each product. The target cost
Ctc
is the difference between the target selling price and the target profit
margin. Note that the
tc
subscript indicates numbers derived under the
target costing approach. This relationship for the target costing approach is
shown in the following equation:
C S P
tc tc tc
.
Once the target cost is set, the company must determine target costs for each
component. The value engineering process includes examination of each
component of a product to determine whether it is possible to reduce costs
while maintaining functionality and performance. In some cases, product
design might change, materials used in production might need replacing, or
manufacturing processes might require redesign. For example, a product design
change might involve using fewer parts or reducing specialty parts if the
company can use more common components. Several iterations of value
engineering usually are required before it is possible to determine the final
target cost. Suppliers also play a critical role in making target costing work. If
manufacturers with market power decide that there is a need to reduce the cost
of specific components, they will pressure suppliers to find ways to reduce
costs. Companies such as Toyota and Nissan might, in some cases, offer
incentive plans to suppliers who come up with the best cost reduction ideas.
8-44 In theory there is no reason to assume that target costing, or at least parts of
it, cannot be applied to service organizations. However, the method was
developed for products requiring discrete manufacturing processes and short
product life cycles. In a bank, products (or services, depending on how you
look at it) would include checking accounts, savings accounts, all types of
loans, etc. The bank could follow the steps outlined in Exhibit 8-4 and do
market research to determine customer requirements and product
specification. Customer requirements would include the desired interest rate
on a checking account, the level of attention needed to open these accounts,
the choices for colors and designs on checks, etc. Next, the “target selling
price” or the cost to the customer of opening and maintaining the checking
account would be determined as well as the target volume or the number of
checking accounts that the company desires to service. The target profit
margin would have to be determined based on calculations related to the
amount of income earned from customer accounts. The target cost then
would be the difference between the target selling price and the target profit
margin.
The following approach can be used. Using the five-stage benchmarking
model below, the instructor may wish to select various approaches
beginning with the choices on the dimensions in Stage 3 and continuing into